What Is Blockchain Technology and How Does It Work?
Blockchain and cryptocurrency worlds seem to be complicated at first glance (and maybe from the second one too). The crypto industry moves towards mass adoption. However, this process takes too much time, mostly because of the complexity of blockchain technology. There are hundreds of Youtube videos, a long list of crypto articles, and other types of learning materials that try to put blockchain into simple terms. It doesn’t work every time, but the crypto community is slightly growing.
Changelly has been on the market since 2015. We always try to provide insightful and comprehensive articles about crypto events, blockchain basics, price predictions, and so on. Today we are going to observe the main pillar of the whole crypto industry and try to explain it in a simple manner. Keep on reading to find out what blockchain is, how it works, and what global problems it might resolve. Here we go.
What is Blockchain?
Wikipedia provides the most common definition of blockchain:
A blockchain, originally block chain, is a growing list of called blocks, that are linked using cryptography. Each block contains a cryptographic hash of the previous block, a timestamp, and transaction data (generally represented as a Merkle tree).
We’ve got a theory that a regular Internet user might not understand such an explanation as it is full of definitions that require a certain background. Let us begin from the start.
At its core, a blockchain is an enormous database, and what is more important is decentralized. Why is decentralization an essential factor in the modern world? The answer is quite simple: decentralization brings privacy and security to your personal data. The fresh memories of Hollywood stars’ photo leakage from the hacked iCloud accounts and a scandal around compromised Facebook’s data lead us to the conclusion that regular databases are highly insecure. Even though corporations spend millions of dollars on the security of their own servers, there is always a chance for a hacker to find a vulnerable spot in the system.
Additionally, big corporations usually have a number of their servers located in one place. Once a bad actor hacked one server, it would be a matter of time when he/she got access to others. In the case of blockchain, servers or nodes are located worldwide or, in other words, decentralized. Therefore, it is technically impossible to hack every computer that is connected to a blockchain.
Imagine if the Great Library of Alexandria was placed on the blockchain. That would mean that every node (a computer connected to the blockchain) would store a Library. Even if 30% of these computers were destroyed, the rest of 70% of nodes would store the whole (!!!) Library. Anyone could access the Great Library until there was one computer with a blockchain database on planet Earth.
As can be seen from the name, blockchain consists of blocks. Each block contains information about transactions executed. Blocks form a long chain of encrypted transactions that have ever taken place on a blockchain. Theoretically, it is not possible to hack a blockchain because once an intruder wants to change, switch, or delete a transaction, the chain will react right away and change all information in blocks consequently. What’s more, blockchain brings transparency as transaction history can be seen in the block explorer at any moment.
So, what is blockchain?
To put it simply: blockchain is a database that stores information in a decentralized way in the form of blocks that are later put in a chain. The information can be added and distributed among all the parties involved but cannot be changed or edited. Every transaction that occurred within the network is transparently visible in the block explorer.
The following question is: how does blockchain work?
How Blockchain Works
In order to explain the way blockchain works, let’s get into some of the essential definitions that help fill in the gaps.
A miner performs the role of an auditor of the blockchain. Miners discover new blocks and verify transactions to add them to the blockchain. At their core, miners aim to sustain a healthy environment within a particular blockchain by discovering new blocks, verifying transactions, agreeing on new updates, and so on. Notably, anyone can become a miner if he/she has proper mining equipment powerful enough to do complex mathematical computations.
The miners verify the transaction. Once he/she proves 1 Mb of transactions (which is actually a block), the miner gets rewarded. 1 Mb of transactions can consist of one transaction or even thousands. However, the miner who verified the transaction must be the first to get a reward.
Hash is an integral element of blockchain technology. It provides security to the system and encourages miners to do their job and get a reward.
A hash is a function that converts an input of letters and numbers into an encrypted output of a fixed length. A hash is created using an algorithm and is essential to blockchain management in cryptocurrency.
Hash can be considered a ‘digital footprint’ of data, and a cryptographic hash function processes it. The same hash will be generated according to the same input. However, if you slightly change input (be it a coma or any other mark), the hash will change completely. Once an intruder decides to alter the chain, the rest of the information in blocks will be changed.
Miners are randomly generating 64-bit hexadecimal numbers, which is called a nonce (number only used once), as fast as possible. In Bitcoin mining, a nonce is 32 bits, and a hash is 256 bits. The first miner, who generates a nonce equal to the target hash, gets a reward.
As mentioned above, blockchain is a great database that stores data in the form of blocks meaning the system is structured. Each block keeps a certain amount of information. The capacity of one block in the Bitcoin network is 1,000,000 bytes or 1 megabyte. One BTC block also contains its own hash and a hash of the previous block. Bitcoin miners generate one block every ten minutes. The Bitcoin network is capable of producing around seven transactions per second.
Following all the described definitions, let’s provide an example of how blockchain works.
You decided to send 1 BTC to your friend – the transaction is sent to the Bitcoin network – thousands of BTC miners have started to verify your transaction in order to add it to the next (or current) block – the network of computers (nodes) try to solve difficult equations to find the right hash of the block as fast as possible and to approve the transaction – your transaction along with other transactions in the network is verified – all transactions are put in the block that also has its own hash (that miners solved) and the hash of the previous block – the newly created block is added to the Bitcoin chain – your friend received 1 BTC. The transaction is executed and can be seen in the BTC block explorer.
Despite the complexity of the algorithm behind a single transaction, miners process your transaction in around ten minutes and get rewarded accordingly.
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Is Blockchain Private?
Most blockchains are public or permissionless, which means anyone can join and participate in the network, see transaction history or any action that’s been taken within the blockchain, etc. When a blockchain is publicly available, there is no central authority that controls the chain. The network is purely decentralized, and every participant of the network plays its role.
Examples of public blockchains: Bitcoin, Ethereum, EOS, Cardano, etc.
However, there are private blockchains that follow different rules. Only authorized users can access a private blockchain. In this case, the network is permissioned. There can be one or more entities that control the blockchain. When speaking about a private blockchain, it is also important to note that the transaction details will be seen only by those entities which made the transaction. Other users will not be able to see or access such information in any manner. When crypto mass adoption enters our daily lives, private blockchains will be an integral part of big (and small) companies. Permissioned networks allow storing a huge amount of data in a super-secure way.
Examples of private blockchains: Hyperledger, world-famous companies JP Morgan and MetLife use their own private chains.
Is Blockchain Secure?
Blockchain is a synergy of difficult mathematical computations, advanced cryptography, and consensus mechanisms. At the end of the day, it is all about math – it protects the system finely. To process a transaction or, in other words, to add it to a block, miners that are spread worldwide (remember: decentralization) try to solve a complex mathematical problem created by the system. This mathematical problem is created using an irreversible cryptographic hash function. Thousands of miners seek a solution that consists of random numbers that, in its turn, are combined with the previous block content.
At the dawn of Bitcoin history, anyone with a regular computer could mine BTC effortlessly. Today, miners need to obtain equipment powerful enough to guess the right numbers and solve the mathematical problem. It is also important to do it before others. Otherwise, there will be no reward. The miner that resolves the problem faster than other miners gets the right to add the block to the chain. In terms of security, a hacker needs to obtain over 51 percent of the network’s hashing power, and this is nearly impossible. A 51% attack will be explained below.
Blockchain vs. Bitcoin
In 2009, someone named Satoshi Nakamoto introduced a new vision of secure data storage and payment solution Bitcoin. The system consisted of both a blockchain platform, Bitcoin, and a cryptocurrency of the same name with the BTC ticker. So, in this way, blockchain and bitcoin are not opposite entities. On the contrary, they complement each other.
The elements of blockchain-like technology were introduced back in 1982 by cryptographer David Chaum. His dissertation “Computer Systems Established, Maintained, and Trusted by Mutually Suspicious Groups” contained the current blockchain protocol concept. In 1991, two researchers Stuart Haber and W. Scott Stornetta described a cryptographically secured chain of blocks that would allow the creation of a system where “document timestamps could not be tampered with.” However, only Satoshi Nakamoto could introduce a live application (Bitcoin) of blockchain technology back in 2009.
Public and Private Key Basics
Just like ordinary keys, both public and private keys allow users to ‘open’ messages. Public and private keys are essential parts of asymmetric cryptography (or public-key cryptography), which in its turn is the main component of blockchain. Each participant of the network (miners, users, and others) has two types of keys. Both keys are used together in order to send and receive transactions, encrypt, and decrypt messages. Every public key matches one private key.
Let us provide a few words of how public-key cryptography works. Imagine Jen and Dany. Jen wants to send a super-secret message to Dany, and they decide to use asymmetric cryptography to do so. Both of them have two pairs of keys: Jen has two keys (public and private), and Dany has two keys (also private and public).
First, Jen and Dany exchange their public keys. Now, each of them has three keys: his/her own private and public keys and a public key of each other. Jen is now ready to send a secret message. She encrypts it with Dany’s public key and sends it to Dany. As we mentioned above, public and private keys complement each other. So, once Dany receives Jen’s message, he can only decrypt it with his private key. In this situation, no one (even Jen) can read Dany’s message as it can only be open with Dany’s private key.
Two important moments must be taken into consideration:
Users must not expose their private keys under any circumstances. Knowing your private key, a bad actor can withdraw your funds, compromise your personal data, and do whatever he/she wants with your information. Therefore, if any internet user, whether it is an admin of a group, your mom, or Satoshi Nakamoto himself, asks you to send him/her private key – don’t.
It is important to note that if one knows your public key, he/she cannot access your private key.
Various internet articles have clickable titles like: How to hack a blockchain? Three ways to hack blockchain, and so on. Truly speaking, there is just one hypothetical situation of malicious users to obtain control over a blockchain. This is called a 51% attack.
To understand a 51% attack in its full, here are brief crypto basics on consensus protocols. Back in 2009, a creator of the first cryptocurrency, Satoshi Nakamoto, introduced a proof-of-work (PoW) algorithm in his bitcoin white paper. According to the document, all participants of the network (nodes) have to solve algorithmic tasks using the hashing power of the hardware in order to add new blocks to the blockchain.
Once a miner or a group of united miners (a cartel or a mining pool) possess more than 50% of hashing power over the network, they can control the network. Controlling the network means the bad actors will be able to double-spend their coins as well as decide what transaction to process and add to the blockchain.
However, a miner who obtains 51% or more of the network’s hashing power cannot reverse transactions that have already taken place, seize the funds from the accounts, or create new coins.
To initiate a 51% attack on the network that is built upon a proof-of-stake (PoS) consensus mechanism, a participant of the network must obtain over 51% of the cryptocurrency.
Blockchain’s Practical Application
We can’t deny the fact that blockchain is moving towards mass adoption and can offer multiple benefits to businesses and end-users. The technology has been on the market for eleven years now, and today we are able to harvest first yields from the blockchain’s practical applications.
Banks can greatly benefit from blockchain technology implementation. Since blockchain can be accessed 24/7, banks’ clients can transfer money and make banking operations at any time. Moreover, blockchain enables more security and trust in such delicate sectors as banking. Each bank claims to be secure, but DLT can multiple increase the level of protection.
Use in Cryptocurrency
Blockchain is a backbone for cryptocurrencies. Both a digital currency and a blockchain create a universal platform that can be applied to a range of sectors and industries. Having basic coding skills, one can even create his/her own cryptocurrency. For example, the Ethereum platform offers an environment and multiple tools to do so.
Coins are native units of exchange within a particular blockchain. For instance, the Bitcoin network has BTC, Ethereum’s native coin is Ether (ETH), Cardano uses ADA coin as its native cryptocurrency, and so on.
Blockchain technology was introduced to bring transparency and trust to the digital finance sector and data sector. Like any other sector of the real world, the Healthcare industry suffers from a range of issues like lack of universal access, interoperability, security, etc. Once implemented in healthcare, blockchain can improve the whole system and help it to overcome issues that the sector is currently facing.
There are real use cases of healthcare applications built on blockchain that already help doctors and patients to overcome a range of issues. For example, the Solve.Care project.
Solve.Care is a global platform aimed at bringing healthcare administration, security, cost reduction, and many more to the Healthcare industry. Solve.Care allows for setting appointments and managing payments. Another worthy project is FarmaTrust. The platform is developing a fast, scalable, and secure blockchain solution that automates all stages of pharmaceutical product tracking in the supply chain.
A smart contract is a computer code that can be built on the blockchain. A smart contract is a self-executing contract that is used to verify and negotiate a contract agreement. A contract can be executed once all the conditions have been met. In this case, a smart contract can be a useful tool in property records use, the last will making, etc.
In 2019, giant corporations like LVMH, Nike, and New Balance decided to support the blockchain industry to enrich their own businesses and save customers from counterfeit goods. The total value of fake goods traded in 2013 was $461 billion. In 2019, the illegal market of counterfeit goods could ‘steal’ around $4.5 trillion from the original manufacturers, where 60-70% of the total sum belonged to the luxury sector.
Corporations bear gargantuan losses while end-users get fake and (most of the time) low-quality products. The ecological situation is getting worse due to the huge volume of producing goods that will be recycled improperly if not used.
By introducing blockchain to the supply chain, both corporations and end-users will benefit from it. Big companies will save tons of money, while customers will be able to buy and consume authentic products.
Blockchain Usage in Agriculture
The blockchain-based agricultural platform will keep order in all sectors that are responsible for the production, distribution, transportation of products. The information about all sectors regarding agriculture is safely stored on a blockchain giving access to authorized (if it’s a private blockchain) or all users (if it’s a public network).
Thus, a company can monitor the efficiency of labor work, water/seed/other use. Data provided by drones that are usually used in agriculture can also be stored on a blockchain. This gives a company a complete picture of the use of resources. Thereby, blockchain provides an opportunity to build a strategy that will be more efficient in terms of resource usage. Consequently, companies can increase yield by seeing all the vulnerabilities within their businesses and resolve them on time.
Uses in Voting
Blockchain can benefit and upgrade the electoral system. We’ve already described the way blockchain works. In this way, when the technology will be applied to the system, it can bring transparency to the voting process as data within the blockchain cannot be changed, edited, or deleted. This fact will also eliminate the chance of unfair elections or corruption.
The recent U.S. elections showed weaknesses that are currently experiencing the modern voting system. If the elections were held on the blockchain, the process of vote counting would take seconds, while no one can doubt the fairness and honesty of the final results.
In 2018, West Virginia became the first state to let citizens vote via blockchain-based mobile application.
Advantages and Disadvantages of Blockchain
Just like everything else, blockchain has its pros and cons. We’ve tried to observe blockchain from different perspectives to provide a comprehensive look at advanced technology.
Accuracy of the Chain
Blockchain practically eliminates the chance of an error when a user wants to initiate a transaction. Compared to the regular banking sector, there is always a chance of human error, which can lead to funding losses.
Since blockchain eliminates third-party interference, there are great cost reductions that are supposed to be paid to a middleman. Once the blockchain is introduced to our daily routine, there is no need to pay banks’ commission, pay an attorney to write a will, and so on.
Remember our example of the Great Library of Alexandria? In case you want to store your data on a blockchain (via decentralized applications, for example), you can be sure that no one will ever edit or delete your files. Decentralization also brings freedom of speech. Steemit is a social network built on the Steem blockchain that enables authors to say anything they want and gets paid for the articles. If Twitter or Facebook were based on blockchain, nobody would be able to delete or change users’ posts (this is a great problem for countries with authoritarian governments).
Cryptocurrency transactions are executing 24/7. The crypto market never sleeps, unlike the regular stock market. The thing is, crypto transactions are more efficient as there is no third party to authorize your transaction. Hence, the time of transaction processing is reduced considerably, along with the possibility of human error. This is between you and decentralized nodes only. Such a situation creates an environment capable of executing transactions in a more efficient way. Traders get instant access to the market of crypto assets and no longer depend on the working hours of a stock market.
However, in order to interact with a blockchain directly, one should use decentralized exchanges (DEXs). Using regular cryptocurrency exchanges, a user should understand that a crypto exchange plays the role of intermediary.
Blockchain technology strives to bring security to your personal data. Public blockchains like Bitcoin transparently show all transactions made within the network. If a user knows a transaction ID, he/she can easily find transaction details in the block explorer. Yet, some blockchains value privacy at the highest level. Monero (XMR) claims to be a private digital currency. Transactions made on the Monero blockchain are untraceable. This fact brings even more privacy to users.
Decentralization provides high security to transactions made on the blockchain. Thousands of miners verify transactions to add them to a block later. We’ve already described how blockchain works. Each block contains its own hash and the hash of the previous block. If an intruder wants to change transaction details, he/she will meet many issues. Once a transaction is edited somehow, the rest of the blocks will be changed. Besides, it’s nearly impossible to ‘hack’ blockchain. A bad actor needs to rule over 51% of the network’s nodes (computers). Due to decentralization and efforts needed to be wasted on such an activity, blockchain is a hacker-proof system. Therefore, transactions are secure.
Banking the Unbanked
As of 2020, there are over two billion people in the world that don’t have bank accounts. Most of these people live in developing countries and do not have access to basic banking services. Blockchain technology can solve this problem and provide anyone and anywhere (regardless of race, nationality, gender, etc.) with financial solutions to store savings in a secure and decentralized way.
Disadvantages of Blockchain
Technology cost is a fair argument if we talk about blockchains that utilize proof-of-work (PoW) consensus algorithms (Bitcoin, Ethereum, Monero). In this case, the mining process requires a large amount of electricity that is bad for both miners (that need to pay bills) and the environment (mining produces carbon emissions). Still, the crypto industry introduced other algorithms like Proof-of-Stake (PoS) that do not consume much electricity and are more efficient in terms of productivity and availability – they don’t require expensive mining equipment like PoW blockchains.
One may say that speed inefficiency might be a problem on the way to mass adoption. Technically, it is not quite correct. Blockchain is only eleven years old, and the technology is under continuous development. Every year, the crypto community meets new technological breakthroughs in terms of DLT.
It is true that the most recognizable blockchain, Bitcoin is capable of processing seven transactions per second (tps). However, there are a lot of other notable distributed ledgers that can process a larger number of transactions and also provide more suitable conditions for developers, businesses, users, etc.
This year, the EOS blockchain’s testnet Jungle announced that it could achieve 9,656 tps. The EOS blockchain itself can handle over 4,000 tps. Another notable mention in this regard is Ripple, which is capable of processing 1,500 transactions per second while having the ability to scale up to 50,000 tps. Visa can process over 2,000 transactions per second for comparison. So talks about blockchain’s speed inefficiencies are quite unfair.
Blockchain brings such long-awaited anonymity and privacy of personal information, but unfortunately, such advantages are widely used by bad actors. One of the reasons why governmental structures don’t want to implement blockchain is that technology is used for illegal activity. Some blockchains enable untraceable transactions, which seem to be a perfect cover for terrorist organizations, drug sellers, and so on. Cryptocurrencies like BTC, Monero (XRM), and other digital assets are used in ‘the black markets’ and on ‘the dark web,’ allowing recipients and receivers to stay anonymous.
We’ve already mentioned that theoretically, blockchain is hacker-proof. There are several ways to ‘hack’ blockchain. If we speak about PoW-based blockchain, a hacker needs to obtain the 51% of the network’s computational resources in order to compromise the blockchain (so-called 51% attack). To hack the Bitcoin chain, a bad actor needs to conquer 51% of all miners’ computers. As of December 2020, there are over 1,000,000 miners out there. Well, good luck, hacker.
If we speak about PoS-based blockchains, a hacker will need to take over 51% of all stakeholders within the network. Hardly such a burning desire to rule a blockchain is worth the effort, time, and money.
Blockchain Explained: Bottom Line
We do hope this article could help you to get into blockchain basics. In case you still have any questions, we are always happy to help you with them. Just leave a comment in the section below and wait a while. Changelly cares about its users and helps them to exchange, sell, and buy cryptocurrency within several minutes. Purchase crypto with a credit card (Visa, Mastercard), bank transfer, or even Apple Pay instantly.